Nokia’s Licensing Deal With HTC Confirms Long-Term Patent Potential

Nokia (NYSE:NOK) illustrated the strength of its patent portfolio Friday, when it settled all pending patent disputes with HTC and entered into an agreement to collaborate on future technologies. Although the companies did not reveal much about the deal, given the highly confidential nature of such patent agreements, Nokia did say that HTC will pay it royalties and that its licensing offering will be bolstered by the inclusion of HTC’s LTE patent portfolio. [1] The royalty rate that the companies agreed upon is tough to gauge, but given that HTC’s fortunes in the smartphone market have declined rapidly over the last couple of years, it is unlikely that the deal will move the needle on Nokia’s earnings by much. HTC’s smartphone market share has declined from all-time highs of around 10% in 2011 to about 2% in recent quarters. [2] The near-term impact of this deal on Nokia’s valuation will be clearer when the company releases its next-quarter results and provides an updated annual royalty run-rate guidance for the year.

However, more than the immediate revenue impact, the deal confirms Nokia’s ability to monetize its vast IP portfolio, which includes a large number of implementation patents that haven’t been licensed yet, in the coming years. Following the pending sale of Nokia’s handset business to Microsoft, IP licensing will become one of the key areas of growth for the company. We conservatively estimate that the licensing business accounts for about 13% of Nokia’s value, given the uncertainties surrounding the timing of future deals and the royalty rates that the company will be able to negotiate in the coming years. However, the Microsoft deal has increased Nokia’s leverage in licensing negotiations by eliminating the need to cross-license and defend its handset division. There could therefore be a significant upside to our $7.50 price estimate if Nokia manages to monetize a greater proportion of its patent portfolio and is able to renegotiate existing contracts at higher rates when they come up for renewal in the coming years.

One of the bigger near-term impacts that the HTC deal could have is in deciding the future course of Nokia’s royalty renegotiations with Samsung, which is the biggest Android player and accounts for almost 35% of the smartphone market currently. Nokia recently extended its patent licensing contract with Samsung, which would have otherwise expired by the end of 2013, by another five years. The companies haven’t agreed on the royalty rate and other contractual terms yet, but expect to settle through arbitration in 2015. Given that the new HTC agreement involves implementation patents, it positions Nokia well in negotiations with Samsung – as well as others down the road – as it looks to increasingly monetize its IP beyond the standard-essential patents, from which Nokia derives almost all of its licensing revenues currently.

Standard-essential patents are those that have contributed to creating industry standards in 3G or 4G and are required by regulations to be licensed to others at fair and reasonable rates. These patents account for about 10% of Nokia’s IP portfolio. The rest, which include implementation patents, haven’t been monetized well since Nokia historically preferred to use them to defend its handset business instead. We estimate that Nokia’s handset royalty rate is less than 0.3% currently, as compared to, say, Qualcomm which licenses out the breadth of its patent portfolio to handset makers and hence collects a licensing fee of about 3.2% on the ASP of each device containing its technology. As a result, while Qualcomm has over 250 patent licensees paying it recurring annual royalties currently, Nokia has only about 40. [3]

Enforcing IP in Emerging Markets

With the sale of its mobile device business, Nokia is free to license the rest of its patents as well as bring more of its erstwhile handset rivals under the fold of its essential patents. It also faces less danger of being countersued, and should therefore have greater bargaining power in setting patent licensing terms going forward. We expect the patent deals with Samsung and HTC to get the ball rolling for more such deals in the coming years, especially with a number of Asian handset manufacturers that are gaining share in emerging markets.

However, the timing of such deals is uncertain considering how long patent lawsuits can take to settle. It is also tough to ascertain the royalty terms of such deals, which are usually shrouded in secrecy. Also, Nokia could face regulatory issues while negotiating licensing terms. The Chinese government hasn’t given the go-ahead to the Nokia-Microsoft deal yet, probably due to concerns that it may cause handset prices to increase and 3G/4G adoption in the country to take a hit, should Nokia misuse its patent strength to charge high royalty rates. The European Union has also voiced similar concerns. While speaking at a conference in December, European Competition Commissioner Joaquin Almunia said that he would have no qualms launching an antitrust case against Nokia should the company act too aggressively in enforcing its IP. [4] This could potentially limit the royalty rates that Nokia can charge for its patents going forward.

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